TCS-BaNCS-Research-Journal-Issue-9

Repositioning for GrowthVolume 2Issue 5



FOREWORDCost Mutualization – Is it for real?Capital markets are as vibrant the art of initiating and executing of other market participants.as ever across the globe. There more trades respectively. The Same-day settlement wouldis more trading. There are more entire ecosystem is able to absorb require market participants tovenues. And, more value changes such high volumes of trade – last “pre-position” their assets and,hands faster. There is greater year’s peak becomes this year’s if the transaction involved an‘systemic risk’ and, as a result of average – and it is amazing to see extension of credit, to arrangethis, far more regulations. The that one firm is selling and the for that credit at or before themarkets will continue to grow and other is buying and paying for it. time a trade was placed. Thischange to make sure that exchange would reduce “fails” by severalof value happens at faster rates But, the interesting thing is that more percentage points……and greater amounts than ever the systems of today provide for at Faster trade settlements in equitybefore. But, still, T+0 has been least two days to make good the markets could also help reduceelusive. trade, and there is no rule in place lags between those markets and to ensure in advance that the seller the derivatives markets -- bothWhat is preventing securities firms and the buyer actually have the exchange and over-the-counterfrom guaranteeing, in advance, a capacity to complete the trade that -- thereby reducing the need fortransaction that sellers possess the is initiated. credit on inter-market positions,assets of and that they say they are and making credit available forselling, to buyers who have readily In support of T+0, or same-day other purposes…available cash that enables them to settlement, Arthur Levitt had thisbuy these same assets? to say when he was the chairman Such a single-minded pursuit of the Securities and Exchange of increased value creation, theIf I am not mistaken, more than Commission: resultant volumes and globally60% of all trades in traditional inter-connected market placesasset classes now take place …we could reduce risks by mean a business that reliesin algorithmically-driven, low shrinking settlement periods heavily on technology. Therelatent, high-frequency trading further, even as far as same- are so many link-ups and hand-infrastructures. Traders in day settlement. “T+0” would offs. Simply put, the evolution ofsecurities firms and trading have many advantages. Faster the marketplace, the practicesmarketplaces have both been settlement would further reduce therein and regulations haveworking hand-in-glove to master the risk of loss to investors and made capital markets technology intermediaries from the insolvency TCS BaNCS Research Journal 3

one of the most complex. Several efficient and stay relevant in the resulting in reduced platformindustry efforts and standards marketplace. Firms want to share building and maintenance costs,are, in concurrent, making valiant technology more than ever before continue to push for the sharingattempts to collaborate and and achieve cost mutualisation of reference data and achievesimplify technology. Be that as through internal shared services or higher STP, and move towards ait may, firms continue to face industry utilities. It would certainly single touch model for clearing“availability angst” and spend help if firms look at their internal and settlement. The cost per tradehuge sums on technology just to trade workflows and remove metric is bound to go down furtherkeep it going or for the purpose of inconsistencies in their pursuit of and, then, perhaps T+0 won’t bemodernization in the domain. achieving lower cost per trade. that elusive. Technology alone cannot be anThe cost per trade benchmark is equalizer. We believe that such costpushing firms to slice and dice mutualisation is for real.their cost of ownership across Let us hope that firms will continuetechnology and operations and to drive higher trade volumes, Have a great Sibos 2014 and enjoyto look for avenues to make them share common technology Boston. N Ganapathy Subramaniam President – TCS Financial Solutions Tata Consultancy Services4 TCS BaNCS Research Journal

EditorialAll regulation is global because firms both from an approach and technology players seeking a more efficient wayoperate globally. Even those directives viewpoint. of management, thereby, bringing in adefined for a specific market or region are unique opportunity for CSDs in someglobal in their impact. Regulations--be We begin with an article exploring the markets to adopt a broader role andthey complex, ambiguous or arcane--are implications of regulation covering the introduce much-needed efficiencies.here to stay. To quote a leading banker, asset management and fund sector“the demands placed by the burden of followed by how the EMIR regulation An opportunity to streamline processesregulation on the human capital of a can impact CCPs. MiFID I promoted in the mid-office and reduce operationalfirm and its operational capabilities are competition between investment services, risks has come about thanks to the recentunprecedented.” The industry is in a state introducing more choice and protection shortening of the equity trade settlementof confusion about the scope of these for investors; however, the financial crises cycle from T+3 to T+2. But, whethermulti-hued regulations and is therefore of 2008 exposed its shortcomings. The reducing the settlement cycle will increasebecoming more risk averse. On the other European Commission then revised the the risk of settlement failure, particularly,hand, ‘standards’ established by global directive to bestow some resilience to the in the absence of a trade matching orconsensus unlike regulations are more financial markets in the form of MiFID II. confirmation process is the question. Wea topical assessment of risk locally. The One of our authors takes a deeper look at assess its potential impact.question arises about whether global’ the impact of MiFID II on financialstandards can indeed be a reality. The onslaught of regulatory and The co-existence of electronic and market changes have driven highFind out more about all of this and certificated holdings has caused much levels of investments in IT, processing,some in the latest edition of the TCS complexity and delays in settlement. infrastructure and maintenance,BaNCS Research Journal that we will be Investors with dual holding suffer from forcing financial services firms to looklaunching at SIBOS 2014. Our authors the lack of a consolidated view of their at innovative ways to reduce costs andelucidate opinions and perspectives portfolio while issuers grapple with the streamline operations. Reasonably largeabout some game-changing regulations complexity of reconciliation between investments in IT for large custodiansand standardization initiatives while also a certificated and electronic holding. are justified, however; for investmentproposing ways to manage them better, This, naturally, has led to market managers and broker-dealers, who deal with far fewer corporate actions andAnjana Srikanth processing, a platform or utility model that can help mitigate risks and reduceEditor/General Manager costs associated with manual processingMarketing, Communications and Research is fast emerging as an option. The industryTCS Financial Solutions is moving towards such multi-tenant utilities that promise to bring in scale, productivity and increased STP. We take you through some of what is involved in this approach and how firms can fine-tune an optimal utility model to best suit their business needs. Happy Reading! TCS BaNCS Research Journal 5

Editorial Advisors Dennis Roman Vice-President TCS Financial SolutionsArun Arunachalam R VivekanandPrincipal Consultant Vice-PresidentTCS Financial Solutions TCS Financial Solutions Malini Raman Senior Consultant TCS Financial Solutions6 TCS BaNCS Research Journal

what’s inside... VOLUME 2 ISSUE 5 8 Emerging Fund Industry Regulation-Impact on the Securities Industry 14 Standards in Corporate Actions – How much longer? 20 EMIR and its significance for Central Counter Parties (CCPs) 26 Integrated CSD and Registrar Architecture 32 ESMA Announces Consultations on New MiFID II Reforms 38 Asset Servicing Utility – The Reality 44 Shortening the Securities and Cash Settlement Cycle from T+3 to T+2 52 PPAs (Post Payable Adjustments) Continuing to Decrease TCS BaNCS Research Journal 7

Emerging Fund IndustryRegulation-Impact on theSecurities IndustryThe global fund industry has almost USD implications of these changes on the exit the investment was through another65 Trillion of assets under management custodian and investor services industry. shareholder.and is predicted to grow to USD100trillion within the next six years. The The origins of the mutual fund industry The crash of 1929 exposed shortcomingsgrowth of the industry has been fueled by date back to 1774 in the Netherlands in this market, where unwitting investorsthe development of personal investments where Dutch merchants sought efficient in closed end funds lacked avenues forand changes to global state pension investment vehicles, but this did not flow exiting their investments during the bearsystems amidst increasingly aging internationally until the establishment of market. The market crash drove a decadepopulations and state budget shortfalls. the Foreign & Colonial Government Trust of regulatory dissection and definition,In the past few years we have seen in the UK in 1868. Mutual funds landed resulting in three main rafts of regulationsignificant changes in regulation covering in the USA in the early 1890s and rapidly and the creation of the SEC 1940 Actthe asset management and fund sectors, took hold in the form of predominantly that has continued to regulate US mutualand this article examines some of the closed end funds, where the only way to funds for the past 70 years, additionally8 TCS BaNCS Research Journal

introducing the concept of custodian have traditionally been limited to the Impact to the Investor Services Industrybanks as independent record-keepers. professional, institutional sectors. Private banks and wealth management channels A key focal point for the fund industryThe parallels with the post 2008 global are grappling with the challenges of regulators has been around assetfinancial crisis are obvious, and we have aligning their retail and institutional protection, and to enhance investorseen an even broader set of regulations platforms amidst the most significant protection by reducing the opportunitiesemerge both to tighten the regulation of period of regulatory change in history. for ambiguity in the post-trade andthe financial services industry, including custody supply chains. The role of theasset management. The offshore mutual fund market has Depository as a key accountable party for grown significantly in the past decade, a fund’s security and stability has beenThe growth of retail consumer investment allowing fund manufacturers to benefit tightened--a functional responsibility stilland reliance on mutual funds as pension from broader distribution channels in dominated by the leading custodian banksvehicles has forced regulators to continue multiple markets. Europe houses the globally. A range of new requirementsto examine ways to limit non-market largest offshore fund hubs in Luxembourg and liabilities have been placed on therelated risks for investors. This has been and Dublin, and the new AIFMD Depository, increasing liability for thecoupled by trends set by retail investors (Alternative Investment Fund Manager safekeeping of assets by the fund and forseeking access to more sophisticated Directive) that came into effect in July activity delegated to their networks ofinvestment options---products that 2014 marks the most radical changes to agents. fund industry regulation that has been Europe houses the seen in the past 70 years. Many principles Traditionally, the industry has, absent largest offshore from AIFMD have also been adopted proven negligence, not accepted liability fund hubs in by the new UCITS V regulations, and for asset position losses resulting from Luxembourg and hence the impact of these changes is the use of intermediary agents in their Dublin, and the new across the European fund industry. These network, or for assets held outside the AIFMD (Alternative regulations cover multiple areas of focus custody chain of legal ownership control. Investment Fund including transparency, risk management, The shift in regulation is significant – Manager Directive) valuations, delegation and business materially changing the risk profile of the that came into effect conduct. services provided by this sector. in July 2014 marks the most radical changes Alternative Investment Funds were a So how will this change the landscape to fund industry priority due to the demand from retail for the custodian banks and the related regulation that has sectors for access, but where the risks of supply chain? been seen in the past such leveraged vehicles required greater 70 years. transparency and structure. The Lehman At a macro level, there has been global crisis exposed poor practices around debate about regulatory arbitrage collateral and client money segregation across the financial services space, leading to losses from this concentration and we should expect this to play a of activities and comingling and bigger role in how funds domicile and rehypothecation of collateral pools. The where they choose to market their reaction to this has been multi-pronged services. Fund managers have to cover both in terms of moving OTC derivatives the cost of significant new regulatory reporting, clearing and margining on- compliance and reporting requirements market under Dodd Frank and EMIR with substantial new cost requirements. regulations, but also in terms of the Small funds will stop being cost viable new client money regulations requiring clearer and stronger identification and segregation of client monies. TCS BaNCS Research Journal 9

in many jurisdictions with intense like programs expand into other country There has beenregulatory compliance requirements regimes and how this will impact the global debate aboutand may shift their focus to less onerous use of global passport funds. This may regulatory arbitragejurisdictions. We are already seeing further fuel the growth of regional and across the financialgrowth of alternative funds in Asia and sub-regional passport funds aligned to services space, and weSingapore who are looking to leverage regional economic alliances, such as the should expect this tomore balanced regulations to access the ASEAN alliance. play a bigger role infast growing HNW segments. But there how funds domicilehas been significant focus on regional The changes to the Depository liability and where theypassport fund initiatives in territories framework will mean that Custodian Bank choose to market theirtraditionally dominated by UCITS funds, Depository will have to consider more services.including three distinct programs in Asia rigorous approaches in assessing portfolioPacific. These will gain traction if accessing and counterparty risk management. an asset bracket in terms of oversightthe Asian HNW sectors proves desirable. Asset classes will require more definition and monitoring, and custodians will need according to the legal nature of ownership to consider how these are covered byFATCA is already driving changes in the and what evidences possession and their control platforms in a manner farmarketing of funds, and many funds have control for each asset class – for more rigorous than the typical valuationdecided that acceptance of US resident example, the inherent risks between engines. Several custodians had alreadyinvestors carries too high a compliance holding a listed equity through a market moved to create prime services functionscost, and have started to close their funds regulated CSD are very different from under their securities services functionsto these investors. It will be important to those associated with illiquid, unlisted in the post 2008 aftermath, leveragingassess the downstream effect if FATCA- physical securities such as promissory the strengths of their custody functions to notes without any recognized market bring stronger asset segregation models. A range of new security standards. Depository Banks will requirements and cover additional liability for traditionally The securities services industry is liabilities have classified “Out of Network” assets, collaborating both in terms of defining been placed on the including third-party time deposits, standards for Collateral Management and Depository, increasing interests funds/collective investment for defining “Out of Network Assets”. liability for the schemes and private equity funds, bank Positively, we should expect growing safekeeping of assets loans, derivatives, and precious metals. pressure from the industry to migrate Out by the fund and for Derivatives contracts held with third of Network assets into market recognized activity delegated parties such as prime brokers will trigger and regulated market infrastructure to their networks of a need for a new set of counterparty risk entities in a bid to improve the security agents. evaluation considerations as well as the and viability of these investments. Many need for oversight of collateral placed CSDs are already looking at opportunities as margin against these contracts, which also falls under the scope of the new regulations. Derivative contracts were not traditionally covered by custodians and were managed effectively under a fund administration suite of services. The driver for this coverage model was their contractual rather than asset nature, but the regulations put these more centrally into10 TCS BaNCS Research Journal

to expand their asset coverage beyond these risks at a client portfolio level, Derivatives contractsthe traditional scope of listed equities and this will further challenge the shift held with thirdand this should drive demands for new towards risk-based pricing models, that parties such as primecapabilities by CSDs and new areas of seem critical for the industry. brokers will triggercollaboration with experienced service a need for a newproviders in other countries. The We have seen the OTC derivatives set of counterpartyexpansion of activities covered by CSDs industry recognize the importance of risk evaluationis likely to be a trend in the next decade, integrating the back-office with front- considerations asfueled in part by shareholder demands, office decision making tools, where the well as the needbut also due to the emerging competitive requirements of collateral and margin for oversight ofchallenges that market infrastructure can influence the choice of venue for collateral placed asevolution, such as T2S, is driving. trading and clearing, and ultimately the margin against these pricing of transactions with clients. It contracts, which alsoApproaches to portfolio and counterparty will take several years to see whether falls under the scoperisk management should, in theory, any introduction of risk-based custodian of the new regulations.drive the gradual introduction of risk pricing also drives trading behavior forbased pricing by custodians, a shift from Fund Managers, and whether more be liable for losses incurred at sub-the largely operational and network sophisticated risk return analysis models custodian banks, although there arecost-driven models that drive custodian for different assets classes and trading provisions in the AIFMD regulation forpricing today. Bundled pricing models will counterparts impact this sector in the a Depository to delegate this liability tobecome more challenging to justify unless same way as is being seen in the OTC the sub-custodian where it is impracticalvery clear boundaries are defined around derivatives markets. for the Depository Bank to executeportfolio composition and the nature of these directly. Under either scenario,counterparties. Many custodians lack the A key opportunity for the Custodian Bank the emphasis around the standards ofnecessary systems to assess and quantify Depositorys will be the positioning of network management due diligence in-house services as part of the suite of focus is intensified and each Depository The changes to the capabilities. In practice, in-house services will have to evidence far more rigorous Depository liability should carry a lower risk premium for standards for selecting, activating and framework will mean Depository Banks, relative to the potential monitoring their networks of agents. that Custodian Bank exposures with third-party firms, and Systems for the oversight and monitoring Depository will have this should encourage fund managers to of agent performance will need to be to consider more leverage the derivatives, prime brokerage enhanced to ensure clear audit trails of rigorous approaches and prime services units from these activity and approach, to provide clarity in assessing portfolio banks. The industry has been on a drive in the event of any loss incidents. and counterparty risk towards integrated transaction banking management. services with their trading products and services, and we should expect the regulation-related changes to further incentivize centralizing of derivatives and collateral activities with their Depository Bank. But this assumes that Depositories are willing to define a higher charge for oversight of third-party positions and the ability to unbundle these from the existing tariffs. The custodian supply chain is also in the frame where the Depository will TCS BaNCS Research Journal 11

These new requirements on network most notably, in Europe with T2S where The second trendliability may also drive a few different the connection of primary custodians related to networktrends in the custody/sub-custodian through to CSDs is radically changing the liability is the processsupply chain. The largest Depository business landscape for local custodians of delegation ofBanks are already starting to define their and CSDs. Although asset servicing liability to the sub-value propositions in terms of assets held remains outside the system’s initial scope, custodian banks. It isin-house and are considering agendas the opportunity for global custodians to unlikely that this willthat migrate the bulk of assets under connect directly (or via central access be accompanied bycustody in-house. Global custodians will agents) will see the local custodians any risk premium andneed to consider options and solutions largely dis-intermediated from the supply most of the issueson whether to connect existing global chain, unless they are able to adjust their that were mentionedcustody platforms to the markets, or value propositions. as impacting thedevelop incremental local custody system Depository will besolutions. Either way, there will be The second trend related to network passed through to theopportunities for entities in these markets liability is the process of delegation of sub-custodian banks.to adjust their propositions to support this liability to the sub-custodian banks. It isshift in model. unlikely that this will be accompanied by to a fund’s assets in the event of a failure any risk premium and most of the issues of either custodian bank in the supplyWe are already seeing this change coming that were mentioned as impacting the chain. But this does change the traditionalinto play in other parts of the world – Depository will be passed through to the model of custodian responsibility where sub-custodian banks. Sub-custodians will assets held outside a custodian’s legal In practice, in-house also need to become more analytical ownership chain were not deemed as held services should carry of the assets in the client portfolio and in custody. Custodians under this model a lower risk premium will require more sophisticated tools to would increasingly become account for Depository manage and quantify the risks inherent in operators, a model more common to banks, relative to the client portfolios. Sub-custodians will also broker clearing, to ensure that they had potential exposures need to respond to the higher levels of sufficient control of the accounts in the with third-party due diligence from their clients and this absence of a default event scenario. Fund firms, and this should will also translate into more specific and managers would need to consider options encourage fund direct attestations with regards to areas of for their links with CSDs, to ensure that managers to leverage service and accountability. periodic reconciliations provided the risk the derivatives, prime management benefits that such a model brokerage and prime The third potential trend is for funds could bring. services units from to look to hold assets in their own these banks. designated accounts directly at CSDs, as a move to reduce the supply chain risk profile. This trend is already beginning to occur under the EMIR regulations to improve protection and access to collateral and reduce the use of comingled collateral “trust” accounts. Globally, this is not yet common, and many CSDs lack the rules to allow foreign direct holders, but this reduces the challenges in terms of immediate access12 TCS BaNCS Research Journal

From one angle, Conclusions to the potential downside risk in thiswe should expect highly competitive marketplace. But thesophisticated players The tightening of fund regulations question is more about the trigger ratherto arbitrage between will drive changes to the industry, and than the result, in an environment whereregulatory jurisdictions the models that have dominated the banks are under extreme scrutiny in termsas a means of keeping landscapes over the past two decades. of risk capital management.regulation compliancecosts manageable, From one angle, we should expect As we have seen in the derivatives andbut the IT industry sophisticated players to arbitrage CCP markets, the focus on risk will alsois already stepping between regulatory jurisdictions as a see incentives for firms to centralize moreforward to automate means of keeping regulation compliance services with their primary provider,many of these areas to costs manageable, but the IT industry is leading to more concentration risk. Thiscontain the impact of already stepping forward to automate is an unintended consequence of thethese requirements. many of these areas to contain the impact changing regulations, and will no doubt of these requirements. Any perception remain under scrutiny. of over-regulation will encourage new regional fund schemes, and the coming Finally, if the cost of running and years will determine whether the global distributing funds becomes too high, we UCITS schemes remain preferable in all may gradually see the investors switch regions. over from the more passive funds and into more direct investment forms, a Custodians will have to develop far trend that is already prevalent in the more sophisticated tools to assess, HNW sectors. The outcome will be largely quantify and manage risk than have been determined by the industry’s ability to required historically. There has been a continue to deliver a value proposition huge reluctance to be pioneering in this relative to other investment channels, industry in terms of fee models, due amidst the growing levels of regulation.Giles ElliottManaging DirectorAlfaSec Advisors TCS BaNCS Research Journal 13

Standards in Corporate Actions– How much longer?Since the financial crisis of 2008, largely made in terms of global regulatory or legal/fiscal frameworks will always takedriven by the need to make the industry collaboration in the areas of ‘Too Big to preferences about dimensions, whichsafer as well as to reduce operating costs Fail’ for the banks, or for instance, Basel standards aim to streamline. So what you– two things have gone on an overdrive: III. Standards, however, are a different will end up with are global frameworksRegulations and Standards. Regulations ball game altogether. Standards start from or templates with regional or localare driven by the need to reduce risks the other side and their reach and impact nuances. At least, that’s the way industryfor the various stakeholders across the is global. They allow for local flexibilities working groups on business processesspectrum, including institutions and in the form of details and fine print, and and harmonization are established.investors. Standardization, on the other offer significant leeway during the actual Hence, it is inevitable that global andhand, while linked closely to operational implementation within organizations. regional nuances co-exist which in somerisk, is always about a business case at way improves the levels of adoption tothe end of the day, in terms of the cost Standards are established by hard global a greater extent compared to what ittake outs from the organization either in consensus unlike regulations which are would have been if it were a single globaltechnology or operations. more a topical assessment of risk locally. template. While their aspirations are global, globalWhile regulators establish the local rules standards seem more of an oxymoron or Corporate actions processing is probablyof the game, some headway is being rather a distant reality. National priorities at the intersection of the drivers of14 TCS BaNCS Research Journal

industry change – tightening up of their flexible and configurable platforms, The progress of SMPGoperational risk frameworks, increased already having helped organizations has been dependentregulatory accountability for client ahead of industry standards or on that made by theservicing, and, reduction of costs of harmonization initiatives. The platforms individual NMPGsoperations through automation and allow for regional and local nuances to acknowledging thatstandardization. This is one of the few co-exist with global standards and more fiscal and tax policiesareas where standards and harmonization importantly also allow organizations to will always be theinitiatives are at play to see what really define their own processes with adequate defining factors incan be streamlined. All this is happening controls in place. Internal automation the pace of change inagainst the background of extremely is in a sense ahead of standards and corporate actions.localized tax and other fiscal policies, harmonization initiatives when reductionwhich themselves have very limited of operational risks and processing costs regulators. This did not specifically includepossibilities of even being considered are considered. The platform vendors are the U.S. Corporate Actions Reporting asfor harmonization across even regional closely aligned to the realization of the part of the mandate and makes it difficultlevels. Corporate actions has found recommendations of the industry groups to justify a business case for its adoption.a balance between the thin line that as well. The issuer community remains divided ondivides Standards from market practices, adoption. The ADR listing community isand adopted the latter as applicable Over the past decade, there has been a anyways much smaller to influence, andto actually drive the business benefits raft of key industry initiatives applicable to hence the DTCC push towards XBRL forexpected typically in standards. They are the area of corporate actions. This paper announcements has taken off in a quietused interchangeably, though, in terms of looks at their evolution and the challenges and steady manner.evolving a business case. they pose before they can really be called a standard that has been adopted for In corporate actions, harmonization asCorporate actions are also a classic case the business case value it sets to create. an initiative has always been aroundof technology or platform vendors, with Let’s probe deeper into the three closely in various forms and groups. All along interlinked initiatives a) XBRL, which is since 1998, global consolidation of the The platforms allow US focused b) harmonization initiatives collaborative standards made through for the regional and in Europe and, c) 15022/20022 message the framework of SMPG and NMPG has local nuances to co- adoption globally. been ongoing. In Europe, the big push exist with the global came from the time corporate actions standards and more DTCC initiated the work on XBRL based were identified as the third barrier of importantly also event announcements, in 2010, and the Giovanni report for cross-border allow organizations currently is running a pilot with BNY settlements in 2001. It was clear that to define their own Mellon/Citibank to automate issuer to Straight-Through-Processing (STP) in processes with investor notifications and announcements corporate actions needed far more active adequate controls in focused on the ADR issuers. This has cross-border dialog. This further resulted place. taken quite a while as it focuses on in the establishment of the Corporate bringing the issuer and issuer agent Actions Joint Working group (CAJWG) in into the standardization fold along with downstream players like asset managers, broker dealers or custodians. There is really very little incentive for them, as the financial risk is borne by the downstream participants in the case of corporate actions processing. The challenge remains in the absence of a regulatory push by the SEC as was the case in the 2009 mandate for filing quarterly reports in XBRL to the TCS BaNCS Research Journal 15

At the end of the factors in the pace of change in corporate coupled with some standardization such day, industry wide actions. The whole operating model as the message formats. Since the effort adoption has to either between SMPG and NMPGs has gained was initiated in 2002, ISO 15022 and ensure business a degree of maturity and SMPG has also 20022 have been hogging all the limelight benefits exist for the defined a model for interaction with in the recent memory in the corporate entire value chain, the other industry groups over a period actions arena. or remove the risk of time. But then as long as NMPG is associated with needed in the whole framework, it The corporate actions harmonization processing. is an acknowledgement of the work initiatives by SMPG have always been that remains to be done in terms of coupled with the focus on leveraging2007 and the 130 odd Market Standards harmonization of corporate actions across the ISO framework for messagingthat came out in 2009 for corporate boundaries. standardization. Not that it took anyactions, and the Standards for General lesser effort in terms of standardizationMeetings in 2010. The 30 odd NMPG groups consisting of of messages than in the case of the various stakeholders, including the broker harmonization forums; however, this wasIn Europe, cross-border harmonization dealers, custodians, and asset managers, a much more amenable task of definingis being driven to a great extent by have made significant progress and technical requirements, as it did not haveT2S. While T2S focuses on cross- made their way into SWIFT and other the local or national policies hinderingborder settlement as the core area, market standards based on the respectiveT2S participants will fail to gain from a markets. Today, one among the biggest The story of adoptionsingle cross-border settlement platform contributions of SMPG has been the Event of 20022 has taken onif participants across CSDs and markets Interpretation Grid (which provides clarity a different dimensioncontinue to follow divergent CA market about the use of mandatory-voluntary when the two bigpractices. These standards also form the indicators and options across more than markets announcedbasis for T2S Corporate Actions Standards 60 events) and the new set of Proxy initiatives in thefor corporate actions on Flows i.e. Market messages in 20022. messaging format.Claims, Transformations and Buyer DTCC announced itsProtection. There are a number of other Apart from national policies, the most Corporate Actions re-projects which are in progress such as daunting task will always be in terms engineering programthe Harmonization of Distributions date of balancing the business case for the based on 20022, and,(H2D) and Reorganizations dates (HDR) to changes proposed along the way for all the T2S initiative inalign market practices to these Standards the stakeholders in the corporate actions Europe, althoughbefore the launch of T2S. value chain – from depositories, asset settlements focused, is managers, custodians or broker dealers. based on 20022.The progress of SMPG has been At the end of the day, industry widedependent on that made by the individual adoption has to either ensure businessNMPGs acknowledging that fiscal and benefits exist for the entire value chain,tax policies will always be the defining or remove the risk associated with processing. As much as the processes could be streamlined, the lack of standardization of messages will always hold back real business synchronization between the market players. As the initiatives with respect to process standardization are underway, there was, of course, broad consensus that these needed to be16 TCS BaNCS Research Journal

evolution, as flexibility in templates up due to efficiency and operational messaging format. DTCC announcedwas real and possible. While evolution benefits, the standards based on 20022 its corporate actions re-engineeringof standards in this sphere has been started emerging as a possibility, though program based on 20022, and, the T2Squite considerable, adoption is another not as a certainty, which slowed down initiative in Europe, although settlementsdimension by itself. Adoption by players, the adoption process. Alternative ideas focused, on 20022. The DTCC Pilot fortypically, is driven by two factors like backward compatibility of the 20022 testing ISO20022 with three financial messages and standards co-existence institutions has been received positivelya) Has it been enforced by the local were thrown in to continue adoption of and been extended to the entire life cycle market infrastructure as a standard 15022 (Keeping investment start date on of the event, including instructions, and for communication? 15022 around 2003, SWIFT apparently various stages are now in the processes had assumed a 10 year ROI before of adopting 20022. Voluntary Events andb) Does it really have a business case planning to cut over to 20022, with Elections processes continue to remain in itself to exist in a stakeholder’s industry consensus about the wind down the key factors given the largely non ecosystem? of 15022 support). And SWIFT has played STP nature of the processes. DTCC is its part in terms of messaging adoption exploiting the ability of 20022 to allow15022 was the first big effort in terms and migration. Nobody wanted to invest supplementary data extensions at theof standardization of communication twice over – first on 15022, and then on individual market or institution level tomessages. Since 2002-2003, the uptake 20022. enable seamless downstream processing.for 15022 has clearly followed the samecriteria as mentioned above. At first, it The story of adoption of 20022 has taken Substantial gains in major markets canwas about if it was being adopted in the on a different dimension when the two help tilt the balance in terms of adoption.ecosystem or not. As it started picking big markets announced initiatives in the On a global level, adoption is slowly picking up with both Japan and Singapore actively adopting it as part of the market infrastructure. The individual players in the value chain finally begin to agree that global adoption will ensure reduction of risk, resulting in a valid business case.Arun Arunachalam In conclusion, corporate actions has proven to be a complex topic for STP andPrincipal Consultant automation. The very fact that standardsTCS Financial Solutions making has been sustained by industry participants over the last 15 years despiteYogesh S the disparate possibilities points to the fact that the industry is seeing progressSenior Consultant in the right direction albeit in smallerTCS Financial Solutions increments to ensure a right balance between global and local nuances and to circumvent a ‘one size fits all’ model. That the forums themselves have started collaborating across geographies reflects the maturity in building standards, proving that ultimately these methods may be the only way out for any forward- looking approach that can sustain momentum. TCS BaNCS Research Journal 17

Members of an avianspecies of identicalplumage tend tocongregate(Birds of a feather ock together) What makes the life of a business head of a capital markets rm challenging? The easy access to global markets, sophisticated investment tools, growing transaction volumes, new investment avenues, among many other factors. At Tata Consultancy Services, we believe that the need of the hour is to ‘Uncomplicate’. And, that these same challenges can be transformed into opportunities for growth. This demands a time-tested, market-ready and move-as-you-grow solution such as TCS BaNCS. A universal nancial platform, it seamlessly integrates front-, mid- and back-o ce operations of capital markets businesses, any place and any time, while also delivering enhanced Straight-Through-Processing capabilities. Its comprehensive multi-asset class, multi-entity solutions help rms implement STP- enabled, scalable processes for custody, brokerage, clearing and settlement, corporate actions and market infrastructure operations. From enabling a customer to consolidate its custody and asset servicing business to processing more than 150,000 corporate events annually, to helping another customer join global stock exchanges in seven months straight, the solution has rede ned the way rms operate. In fact, four out of the top ve securities rms in the world use TCS BaNCS. Now, don’t you think it is time to uncomplicate?Banking | Capital Markets | InsuranceTo nd out how TCS BaNCS can uncomplicate your business, visit http://www.tcs.com/OFFERINGS/BANCS



EMIR and its significance forCentral Counter Parties (CCPs)Post the financial crisis in 2009, the purposes will have to comply. These With EMIR’s thrust onEuropean Securities and Markets participants include banks, insurance increased disclosure ofAuthority (ESMA) came up with the companies, corporates, investment firms, client level positionsEuropean Market Infrastructure funds and CCPs. This paper focuses on the and the resultantRegulation (EMIR) to increase impact of EMIR on CCPs and the role that improvement, intransparency and reduce counterparty technology can play. risk management,risks in the derivatives market. This Segregation comes toEuropean Union regulation covered EMIR and its key tenets the forefront.OTC derivatives, Central Counter Party(CCPs) and trade repositories with a view 1. Segregation and Portabilityto increase stability in OTC derivativesmarkets. Segregation is one of the key tenets of EMIR and affects the entire model of howWith EMIR coming into force, any firm CCPs today hold positions for clearingthat performs transactions in derivatives members and clients. With EMIR’s thrustmarkets either for trading or hedging on increased disclosure of client level20 TCS BaNCS Research Journal

EMIR mandates that and should also ensure that losses in If transfer does not occur in the period CCPs maintain records one account are not exposed to another specified in CCP rules, then the CCP of all transactions account. must manage the risk arising out of such in all derivative positions as per the operating rules, contracts it clears. CCPs need to offer multiple Individually including liquidating of positions and These transactions Segregated Accounts to a clearing assets. should be uniquely member, based on their needs to manage identifiable and allow their positions. The cost and level of 3. Record Keeping for reconstruction of protection for such services should be the clearing. publicly disclosed and such services must EMIR mandates that CCPs maintain be provided on reasonable commercial records of all transactions in all derivativepositions and the resultant improvement, terms by the CCP. contracts it clears. These transactionsin risk management, Segregation comes should be uniquely identifiable and allowto the forefront. The CCP shall manage the risks arising for reconstruction of the clearing process from such indirect clearing arrangements for each contract. Further, it shouldWith segregation, a CCP should be able to with a mechanism to transfer the assets enable competent regulatory authoritiesoffer clearing members: and positions to an alternative clearing to search each record with fields member in the event of a default. concerning the CCP, interoperable CCP, Omnibus Segregated Accounts (OSA) clearing member, and, client and financial for a clearing member where records Such segregation also contributes instrument. and accounts are kept separate, to portability, wherein there is easy enabling the clearing member to movement of assets from one account to For segregation distinguish from its own assets and another, in case of a default. requirements of positions and those from its omnibus EMIR, a hierarchical clients 2. Default Management account structure for position accounts Individual Segregated Accounts (ISA) CCP must have procedures in place and can be expanded to for a clearing member or for its clients should contractually commit themselves accommodate more where records and accounts are in the event of a default of a clearing than one segregation kept separate, enabling the clearing member to transfer the client assets account type for member to distinguish assets and and positions of the defaulting clearing an account owner positions from all its clients member to another clearing member along with a suitable on the client’s request and without additional accountAdditionally, the CCP cannot net the the consent of the defaulting clearing reference for accountpositions across different client accounts member. This applies to both individual identification. and omnibus segregated accounts of a clearing member. The CCP should also ensure that the positions of the member are liquidated without affecting positions of other non-defaulting members. The receiving clearing member is obliged to accept these defaulting positions, if it has been previously been committed to do so. TCS BaNCS Research Journal 21

EMIR also mandates the CCP to certain repository is accessible to regulators accommodate more than one segregationSLAs for such records of account level for their monitoring of the derivative account type for an account ownerpositions and transactions such as -- data markets. along with a suitable additional accountless than six months old to be provided reference for account identification. Thisin a business day and that older than six EMIR implementation for CCP solutions will allow for the creation of multiplemonths within five business days. Omnibus Segregated Accounts (OSA) and We put down some thoughts here on how Individual Segregated Accounts (ISA).4. Repository Reporting CCPs can manage their EMIR compliance effectively. Each position account can be mapped toEMIR mandates the CCP to report the a margin and a settlement account fordata related to derivative contracts and 1. Segregation the purpose of margins and deliveries.counterparties to a trade repository. Additionally, provisions can be created forA trade repository is an organization For segregation requirements of EMIR, multiple margin and settlement accountsregulated under EMIR to manage data in a hierarchical account structure for for a segregation type – say, House anda secure and confidential manner. This position accounts can be expanded toFigure 1: Existing Account StructureLevel 1 CMLevel 2 H U MM N C S1 AAA BBB CCC (Client) (Client) (Client) MM H C C CFigure 2: EMIR Compliant Account Structure CMLevel 1 H U MM C C C S1Level 2 OSA1 ISA1 ISA2 AAA BBB CCC (Client) (Client) (Client) C C H CCC OSA1 ISA1 OSA2 ISA3 OSA122 TCS BaNCS Research Journal

In keeping with • A market participant as a client of a have been included to enable competent the requirements clearing member authorities to search and validate of EMIR, a number transaction and position information. of additional data • A market participant acting as a client Some of the key additional fields available elements have been of a clearing member’s client are unique transaction reference, financial included to enable instrument, transaction date and time, competent authorities Depending on the clearing model that a account reference and client identifier. to search and validate market participant chooses to operate on, For position information, key additional transaction and accounts for the participant are defined fields include end-of-day contract value position information. accordingly, including provisions for and margins. Enhanced search capabilities multiple levels of hierarchy. can be added for transaction and positionClient. Account classification attributes data, including the capability to searchare introduced at the margin account 2. Portability archived data.to differentiate between Gross OSA,Net OSA and ISA. These changes allow a With Segregation, the CCP can offer its 4. Repository reportingclearing member to hold multiple margin clearing members and their clients anaccounts, to allow for clients of similar easy way to manage position accounts, In order to support the Repositoryrisk profiles to be grouped into different with a desired level of hierarchy. reporting tenant of EMIR, Enhancedbuckets. XML reporting is provided with daily In order to support the portability needs transaction and position data, includingThe modified hierarchical account of EMIR and facilitate easy movement of trade, counter party data and mark tostructure ensures that derivatives positions from the defaulting account, the market valuations. These reports arepositions of a clearing member can be following capabilities are provided; available to the CCP to report to the tradedistinguished from positions of their repository. The details of transactionsclients. This applies to the individual • Position Transfer – Allows CCPs to in their original content as well as anyor omnibus types of segregation. The transfer positions in real time on a amendments are made available in theflexibility in margin account mapping derivative contract held in an account report. These reports are available onfor position accounts also ensures that from one clearing member to another a daily basis for reporting to the tradethe margins are calculated and kept repository.separately for clearing member and • Bulk Transfer – Allows CCPs to transferclients. all the positions in all the contracts Enhanced XML from one clearing member to another. reporting is providedThis account structure provides the This is usually done after completion with daily transactionflexibility to support various clearing of the trading window for the and position data,models: exchange including trade, counter party data• A market participant can become a • Account Remapping – Allows an and mark to market clearing member of aCCP account holder (client of a clearing valuations. member or client of clearing member’s client) to move its position account to another clearing member with margins being calculated in the new clearing member. 3. Record Keeping In keeping with the requirements of EMIR, a number of additional data elements TCS BaNCS Research Journal 23

Figure 3: Transition to Segregated Accounts CM S1 C H MM CM S1 C- C- H MMNCM1 Omnibus Individual NCM2C1 C1 C2CCPs are also EMIR rollout in CCPs are driving this change to make themandating clearing derivatives markets safer and better.members to With CCPs having used the last 12-increasingly use 18 months to get to various levels of ReferencesOmnibus Segregated preparedness for EMIR compliance, it isAccounts (OSA) and also a time when CCPs are commencing a 1. Technical standards under RegulationIndividual Segregated rollout of the EMIR needs to their clearing (EU) No 648/2012 of the EuropeanAccounts (ISA) to help members. CCPs and clearing members Parliament for OTC Derivatives,segregate positions alike have now started offering services CCPs and Trade Repositories – Finaland manage risks to their clients to the move to a more report of the European Securities andbetter. segregated position account model. CCPs Markets Authority (ESMA) are also mandating clearing members to increasingly use Omnibus Segregated 2. Alternative Investment Management Accounts (OSA) and Individual Segregated Association Summary on ESMA’s Final Accounts (ISA) to help segregate positions report Draft Technical Standards and manage risks better. Clearing members, in turn, are offering these services to their clients. The journey to EMIR compliance has begun, and, CCPs24 TCS BaNCS Research Journal

Srikanth SrinivasAssistant ConsultantTCS Financial SolutionsJ Ganesh KumarAssociate ConsultantTCS Financial SolutionsM AnandSenior ConsultantTCS Financial Solutions TCS BaNCS Research Journal 25

Integrated CSD and RegistrarArchitectureDespite widespread dematerialization, operational challenges to the capital leading to market players seeking a moremany countries around the world markets, notably, in terms of complexity efficient way of management. CSDs arecontinue to have significant certificated and delays in settlement, corporate keen to play a more central role hereholdings for both equities and bonds. actions processing; delays in moving while also helping make the markets moreWhile there is a constant regulatory push from one form to another for trading or efficient.to encourage transition to electronic safe keeping. Investors who have suchholdings such as the recent CSD-R dual holdings suffer from the inability In many markets, there is an increasingregulations mandating compulsory to have a single view of their portfolios. trend of CSDs also taking up the roledematerialization by 2023, Issuers and Issuers on the other hand are faced with of being the Registrar/Transfer Agent,Central Securities Depositories (CSDs) the complexity of reconciliation between thereby, creating a central repositorycontinue to face challenges in efficiently the certificated holdings managed by of all holdings for the security. Whilehandling electronic and certificated the Registrar/Transfer Agent and the the role of CSDs in making the marketsholdings for equities and bonds. electronic holdings managed by the CSD. more efficient with dematerialization and These and many related challenges, with safekeeping is well established, thereThe co-existence of electronic and the presence of both electronic and now presents a unique opportunity forcertificated holdings pose significant certificated holdings in a market, are CSDs in some markets to take on a wider26 TCS BaNCS Research Journal

Investor Identification Investor ID 1 is an increasing adoption of a Client Code Business Partner ID 1 Investor ID 2 or Investor ID, which is a unique way to Business Partner ID 2 Investor ID n identify an investor. To keep it simple, Business Partner ID n we refer to this as a Business Partner ID. Each Business Partner ID has general information about the investor, including his name, national identification and bank details. This Business Partner ID could also be mapped to other IDs in the market for integration and additional KYC checks.role and create such efficiencies for both the dematerialized holdings as held In a Direct Investor Holding model,certificated holdings. in the CSD and the certificated holdings an investor has an account with the as held in the Registrar/Transfer agent. CSD through the account operator or1. Services provided to investors with With a wide range of corporate actions custodian managing the business for certificated holdings now supported by issuers around the the investor. The CSD has visibility to world, the ability to consolidate and the end investors or clients holding theThe Registrar/Transfer Agent usually reconcile the beneficiary information is of securities. In a custodian holding model,provides a wide range of services to paramount importance. the custodian has an omnibus accountinvestors including Ownership transfer, in the CSD, while the details of the endIssuance and Cancellation, Blocking 2. Integrated approach to holdings investors or clients are held within theand Corporate Actions processing. custodian’s books. The custodian has aAdditionally, the Registrar/Transfer Agents With high levels of KYC (Know Your periodic beneficial disclosure process toalso need to provide periodic beneficiary Customer) norms being enforced in the CSD/Issuers.information to the Issuers, consolidating capital markets around the world, thereIntegrated portfolio for Dematerialized and Certificated HoldingsDepository Business Registrar/ Partner ID Transfer Agency Holding Holding Certificated Certificated CertificatedAccount 1 Account n Account 1 Account 2 Account n Security 1 Security n Security 1 Security 2 Security n TCS BaNCS Research Journal 27

CSDs worldwide support one of the Certificated holdings on the other hand certificated accounts which are equivalentabove models based on market rules and are held in the name of the investor to the “n” physical certificates. However,practices. directly with the Registrar/Transfer Agent. with printing and issuance of certificates This is in some ways similar to the Direct slowly being eliminated in many markets,The dematerialized holdings for the Investor Holding model supported by in course of time, each investor couldinvestor are held in the CSD or with the the CSDs. This mechanism of managing potentially have one such certificatedcustodian (depending on the market investor holdings can be extended to account which represents all themodel), under a holding account. This the certificated holdings using a new certificated holdings held by the investorholding account has an identification type of account – certificated account. for a particular security or issue.number or reference and holds all Such a certificated account also carries asecurities held by the investor. Investors unique account identification number or Such consolidation could mean thatcould have more than one account for reference which represents the holdings investors could in due course have onesettlement, collateral, blocking and other for that physical certificate. The investor holding account with the CSD or custodianpurposes. could potentially have “n” number of such for their dematerialized holdings and oneMovement towards a Single Certificated Account for an InvestorBusiness Certificated Certificated Security 1Partner ID Account Account 1 Security 2 Certificated Security n Movement Account 2 towards Certificated Security 1 a Single Account n Certificated AccountCertificated Certificated Certificated Security 2Account n Account n Account n Security n28 TCS BaNCS Research Journal

While the role of CSDs 3. Registrar Business Processes with Ownership Transfer in making the markets Certificated Accounts more efficient with Ownership transfer from one investor to dematerialization This section indicates how the various another can be handled using account and safe keeping registrar processes can be handled using movements as done for the electronic is well established, the certificated account. holdings held under the CSD/Custodian. there now presents a unique opportunity Dematerialization 4. Multiple/Single Certificated Accounts for CSDs in some markets to take on a The process of dematerialization, i.e., While most registrars mandate using a wider role and create moving from certificates to electronic separate certificated account for each such efficiencies for forms can be handled using account security held by the investor, it is possible certificated holdings. movements from a certificated account to to also rationalize this like the holdings a holding account. As both holdings are held in the CSD. This could further simplifycertificated account for their certificated held under one portfolio, the associated business processes and enable CSD levelholdings with the Registrar/Transfer Register/Transfer Agency confirmation efficiencies in the Registrar businessAgent. could be made optional, thereby, reducing processes. complexity and also reducing time takenWith the CSDs now looking to create for such movements. 5. Conclusionincreased market efficiencies, they CSDare probably in a vantage position to Rematerialization In capital markets, with a mix ofprovide a platform for the Registrar/ dematerialized and non-dematerializedTransfer Agents to offer investors one The process of rematerialization i.e. holdings, the transition to usageportfolio across both dematerialized and moving from electronic forms tocertificated holdings. certificated forms, can be handled on With a wide range similar lines as dematerialization; using of corporate actionsSimilarly, significant complexity in account movements and associated now supported bycorporate actions processing can be Registrar/Transfer Agency confirmation. issuers around theeliminated, as an integrated view of world, the abilityholdings is available to Issuers. Corporate Actions to consolidate and reconcile beneficiary As the electronic and certificated holdings information is are held under one Business Partner of paramount ID, along with associated bank details, importance. the process of corporate actions benefit distribution is simpler and uniform for both forms of holdings. Blocking/Mortgage The ability to have more than one certificated account under an investor portfolio facilitates an ability to block either part or full holdings under a certificated account. TCS BaNCS Research Journal 29

of certificated accounts will have This model also promotes better risksignificant business process benefits and management and also facilitates easyimprovements for the said country’s movement of holdings from one form tocapital markets. The CSD is best another. Issuers can have a consolidatedpositioned to offer an integrated view view of balance across both forms ofof both these forms of holdings and can holdings. Investors benefit from having ahelp simplify key business processes like single portfolio comprising both holdings.transfers, corporate actions, blocking,collateral management and others. M Anand Senior Consultant TCS Financial Solutions R Shivakumar Assistant Consultant TCS Financial Solutions30 TCS BaNCS Research Journal



MiFIDESMA Announces Consultations onNew MiFID II ReformsWhen introduced in 2007 by the European Simply put, if a firm provides investment introduced more choice and protectionCommission, MiFID I was considered to services then it will be subject to MiFID I for investors, there were shortcomingsbe the cornerstone for financial markets via its competent authority. It has been up that were exposed post the financialregulation in the European Union, with to individual EU countries to decide how banking crisis in 2007.far-reaching implications. To date, MIFID best they will implement this directiveI has been responsible for regulating and through their own national law. To address these concerns, the Europeanauthorizing the supervision of investment Commission took the decision to revisefirms, trading venues and trading activities In 2011 the European Commission the directive with the aim of increasingof financial instruments across the 28 published its proposal for MiFID II, and efficiency and resilience of the financialmember countries of the EU region. the European Union has now finally set a markets and to improve market date for the introduction of a number of transparency and investor protection.The aim of MiFID I has been and, still is, new regulations that will come into force These updated rules are now referred toto improve competitiveness across banks over the next few years. as MiFID II.and to harmonize protection in Europeanfinancial markets by creating a single So what is MIFID II? Following the agreement on theregion for all investment services. updated rules, the European Securities Whilst MiFID I promoted competition and Markets Authority (ESMA) between investment services and32 TCS BaNCS Research Journal

Simply put, if a firm What is the impact of MiFID II on the Pools’ but will not tolerate competitive provides investment Financial Markets? distortions, and instead it will bring services then it will greater regulatory scrutiny to these be subject to MiFID From Q3 2014 member states will have trading platforms. I via its competent only 24 months to transpose the new authority. It has been directive. By 2017 all financial service Firms trading OTC derivatives on a up to individual EU firms in the EU will need to be fully bilateral basis will now need to prepare countries to decide compliant with the new rules governing to trade via an electronic trading venue, how best they will the regulation of capital markets. clear the transaction via a Central implement this Counterparty (CCP) and ensure they directive through their So how will MiFID II impact the financial report the trade to their competent own national law. markets? One of the major challenges authority via an approved reporting being that the reforms will extend mechanism (ARM). This will create higherlaunched a consultation process for the regulation to all asset classes; and, processing costs for banks, reducedimplementation of the revised directive. whereas MiFID I only applied to equities; revenue streams and enhanced collateral MiFID II will extend to non-equity ‘Over- requirements.In May 2014 ESMA published the The-Counter’ (OTC) markets.following documents MiFID II enhances organizational By Introducing new market transparency governance so that investment firms• A consultation paper on all topics on and trade reporting requirements for notify competent authorities of all which the European Commission has OTC markets, banks and exchanges will members of their management bodies formally requested technical advice now need to prepare themselves for to ensure they are fit and proper. The large scale changes, both in terms of their• A discussion paper on a selected front-to-back technology platforms and in The European number of technical issues to receive ensuring that market data is available to commission took the feedback from stakeholders regulators on a near instantaneous basis. decision to revise the directive with the aimThese papers represent the first In addition to the extension of of increasing efficiencystep in the process of translating the instruments, the new regulation will also and resilience of therequirements into new rules and expand the number of trading venues in financial markets andregulations. The papers are applicable to the scope of MiFID II. OTC instruments to improve marketinvestment firms, competent authorities, that are traded on a Multilateral Trading transparency andtrade associations, investors and Facility (MTF) or a Regulated Market (RM) investor protection.consumer groups within the European will be required to meet new pre-trade These updated rulesUnion. transparency requirements. The aim is to are now referred to as ensure that all trading is conducted on a MiFID II. regulated trading venue and that identical transparency requirements are evenly applied. The impact will also extend to another type of trading venue, the so called ‘Dark Pools’, where there has been increased scrutiny recently as to date they have remained confidential, allowing traders to interact without pre-trade disclosure to other users or the public. MiFID II will allow the continuation of such ‘Dark TCS BaNCS Research Journal 33

number of additional non-executive which markets they wish to operate firms and regulated markets within thedirectorships will be restricted and in and which ones they will exit. They European Union.reviewed periodically to assess will need to identify the systems andeffectiveness and suitability. Organizations processes affected and secure the On April 15, 2014, the Europeanwill need to safeguard their management investment spends required to address Parliament reached an agreement onteams by making sure that they are of regulatory gaps. the compromise text and adopted thegood repute, have sufficient knowledge updated rules for MiFID.and relevant industry experience to act Given the ambitious timelines, firmsin the interest of their customers and should already be in the process of What are the main areas of reform?maintain market integrity. preparing investment budgets and setting up front-to-back programmes • MiFID II greatly increases the scopeThe changes to reporting rules and to implement the required changes. of new markets and instruments andfurther regulation of trading venues will Technology platforms and business financial products outside the scope ofmean that banks will need to secure large processes will take time to design and the current regulationinvestment budgets to meet these new implement and so it is critical that firmsrequirements. The European Commission have their resources mobilized and • A new category of trading venue calledhas estimated the cost of implementing deployed early enough to deliver the Organized Trading Facility (OTF) willMiFID II to range from €512 to €712 changes required. be introduced for the trading of non-million with ongoing costs expected to be equity instruments such as bonds andbetween €312 and €586 million per year. So what is the MiFID II Consultation derivativesThe consensus within the industry is that process?this is a conservative estimate; the true • Investment firms operating their owncost is expected to be far greater. In an attempt to reform the capital internal trade matching systems are markets, the European Commission has also now obliged to be authorized as aA significant number of technical adopted two new legislative proposals; MTFstandards are expected to follow in 2015 a directive (MiFID II); and a regulationand the timelines for implementation are (MiFIR); the aim of both being to drive a • All trading, where appropriate, mustambitious. Investment firms should now comprehensive review of MiFID. be executed on a regulated platform.be in the process of securing budgets and This means that in addition toresources to understand and implement The split between the new directive and securities, products such as non-equitythese new rules. the new regulation reflects the need to instruments and OTC derivatives achieve a uniform set of requirements (where sufficiently liquid) will haveMIFID II is not the only regulatory change whilst allowing for differences in national to be traded on a regulated platformon the horizon as investment firms have markets. (OTF, MTF or RM)also been presented with an array ofregulatory ruling overlaps and associated The directive MiFID II amends existing The end goal is thatcosts to implement other legislations such provisions on investment services and all standardizedas EMIR in Europe, Dodd-Frank, Volcker investor protection whilst the regulation derivatives are tradedand FATCA in the USA, as well as from MiFIR sets out requirements for trading on either a regulatedother individual regulatory regimes. It is on organized venues, the trading of market, as an MTF orimportant that these reforms and diktats derivative products and the removal of OTF.are not considered in isolation, and firms barriers between trading venues andmust ensure they align their solutions to clearing services.deliver a cohesive response addressing allof these regulatory challenges. Together, both legal instruments will form the new framework governingWhat can firms do to prepare for MiFID? requirements applicable to all investmentFirms will need to assess their businessflows and operating models to decide34 TCS BaNCS Research Journal

The directive that traders are regulated, banks are MiFID II will achieve this by introducing MiFID II amends sufficiently capitalized and controls a new category of platform called an existing provisions are in place for when firms offer direct ‘Organized Trade Facility’ (OTF). This on investment access to electronic venues. new category will complement the other services and investor existing types of trading venues subject to protection whilst the • MiFID II extends the scope of the same requirements for the operation regulation MiFIR sets transaction reporting to all financial of a trading venue as other existing out requirements for instruments platforms. trading on organized venues, the trading of • It introduces harmonized powers and The end goal is that all standardized derivative products conditions for national competent derivatives are traded on either a and the removal of authorities, the European Securities regulated market, as an MTF or OTF. barriers between and Markets Authority (ESMA) and the trading venues and European Banking Authority (EBA) to • Access to CCPs and trading venues clearing services. prohibit financial activities or practices that threaten investor protection, A new framework has been introduced• Competition will be improved for financial stability or the orderly which means that trading venues Central Counterparties and trading functioning of markets (regulated markets, MTFs and OTFs) venues allowing harmonized access will be required to provide access, for the trading and clearing of financial So what are the challenges of MiFID II? including data feeds, on a transparent instruments. Trading venues will be and non-discriminatory basis, to required to provide access to CCPs to • Pre- and post-trade transparency central counterparties that wish to facilitate the clearing of transactions clear transactions executed on a trade executed on a trading venue. Pre and post-trade transparency exchange. Participants will be able to choose an obligations will be calibrated for different alternative clearing provider if they types of financial instruments, including This will improve competition between wish to do so. equities, bonds and derivatives. In CCPs, ease access for newly established addition, to ensure uniform conditions CCPs and harmonize the rules for access• Stronger investor protection is between trading venues, the same pre- to trading venues. achieved by introducing new and post-trade transparency requirements safeguards for client assets and the will apply to different types of venues. • Compliance prevention of unintended use of client This will mean that investment firms instruments. will have to make public pre- and post- In the world of compliance, ESMA is trade information on a continuous basis seeking technical guidance on further• MiFID II introduces new controls across all of their regulated platforms. requirements that aim to increase the for algorithmic trading by ensuring For example, number of aggregated effectiveness and importance of the orders, best bid and offer prices together compliance function. Specific focus is on: with trade volumes would need to be published. ¾¾ Ensuring that the compliance function of an investment firm • Over the Counter (OTC) trading establishes a monitoring program that takes into consideration all To ensure that the trading of OTC areas of the firm’s investment derivatives is captured by MiFID, trading service activities on non-regulated platforms and broker matching systems will be subject to ¾¾ Compliance departments provide regulation. regular written compliance reports to senior management outlining TCS BaNCS Research Journal 35

the effectiveness of the control with minimal human interaction. to implement the new regulatory environment for investment However, there are risks associated with framework. It will also give ESMA greater services this type of trading, such as market abuse powers to coordinate actions between and price fluctuations. competent authorities where necessary to ¾¾ Compliance functions have the enhance investor protection and promote necessary authority, resources, MiFID II will ensure firms have financial stability. expertise and access to all relevant appropriate systems and controls for information this type of activity. Robust measures MiFID II has far-reaching consequences should be in place to ensure that on the regulation of the financial markets,• Safeguarding client assets algorithmic trading techniques do not and there are many other areas of create disorderly markets. Trading venues the reform that we have not coveredTo strengthen investor protection, ESMA must ensure their systems are resilient, -- specifically; heightened investorproposes additional requirements to properly tested and that ‘kill switches’ protection via improved organizationalclient instruments and funds. are in place to temporarily halt trading if requirements, harmonized sanctions there are unexpected and sudden price and fines for market abuse and criminalThese include having proper governance movements. In the future, all traders will behavior, SME access to capital marketsin place and addressing concerns around have to be registered as investment firms. and the regulation of the commoditiesinappropriate lending of client assets. derivatives market.Restrictions will apply to inappropriate In addition, regulatory authorities willactivity and the onus will be on ensuring be enabled to identify trades originating Further information on all areas of thethat firms increase disclosure to their from algorithms so that they can act changes can be obtained from MIFIRclients. effectively against strategies that behave paper no 648/2012 and the MiFID II in an abusive manner or pose risks to the directive, both published by the EuropeanInvestment firms who enter into orderly functioning of markets. Union.arrangements for security financingtransactions for financial instruments held • Greater supervisory powers What are the next steps and timelines forby them on behalf of a client must ensure MiFID II?they have full client consent and that the Many of the changes introduced by MiFIDactivity must be restricted to the specific stem from advice from the European The closing date for responses to theterms to which the client consents. Securities Markets Authority (ESMA). ESMA consultation and discussions papers was August 1, 2014.• Algorithmic trading The European Commission has now stated that ESMA will play a far more prominent ESMA will consider responses to theirMany investment firms now utilize role in developing the technical standards papers and will finalize the draft technicalcomputer algorithmic trading platforms advice for submission to the European Commission no later than 6 months after entry into force of MIFID II and MiFIR. Andrew Dobbs For now, investment firms, asset managers and financial institutions Consultant are assessing the consequences and TCS Financial Solutions challenges presented by MiFID II, its impact to the industry, and, how best they can adapt their current MiFID compliance strategy.36 TCS BaNCS Research Journal

Neophyte’sserendipity(Beginner’s luck) Be it a seasoned banking whiz or a business head at any bank—large or small, the pressure to get to grips with the changing times is growing at an ever-increasing pace. To begin with, the challenges posed by multiple delivery channels, disintermediation, dynamic business models, compliance with global and local regulatory changes, among others, are having profound implications on banks today. At Tata Consultancy Services, we believe that the need of the hour is to ‘Uncomplicate’. To cut through these perplexing and all-encompassing demands with a time-tested, market-ready and move-as-you-grow solution, TCS BaNCS—at any time and any place. With the right mix of interactive, intuitive and instantaneous technologies that deliver exibility, agility and greater operational control, this universal nancial services platform can help your bank drive customer growth, reduce Total Cost of Ownership(TCO) and enhance new product development—all together. How can we make such a promise? Some of our success stories will tell you how. TCS BaNCS enabled a leading bank in India with a network of over 18,400 branches, 25,000 ATMs and over 261 million customer accounts with a uni ed technology platform to create one of the largest homogeneous banking networks in the world. On the other hand, TCS BaNCS re-engineered a Taiwanese Bank with a network of 101 branches to run 24/7 with 99.9% up-time, bringing down its TCO by a staggering 58%. TCS BaNCS has scored leadership consistently in industry analyst reports. Now, don’t you think it is time to uncomplicate?Banking | Capital Markets | InsuranceTo nd out how TCS BaNCS can uncomplicate your business, visit http://www.tcs.com/OFFERINGS/BANCS

Asset Servicing Utility– The RealityUtility, as per the Oxford Dictionary is a How can financial institutions reduce to their success was to offer a standardnoun and represents “the state of being costs and streamline operations further? service package from where a client canuseful, profitable or beneficial” Does the answer lie somewhere in being buy as much of the services offered andAs an adjective, it means - “useful, able to automate with best-of-breed as they needed, giving them the freedomespecially, through being able to perform products or to standardize processing-all to pick and choose and decide how bestseveral functions” with an aim to maximize efficiency? to interface with their existing operations and systems architecture.Reducing costs and maximizing The answer, simply, is to be part ofefficiencies have been high on the a Utility Service, which can take on When applied to Asset Servicingagenda for most financial services operational processing, in a standardized Processing, what would such a standardorganizations for quite a while now. manner, along with other financial service package be like?Even so, after many exhaustive rounds organizations, on a shared platform(after rounds) of automation, change with common processes and a single, This is best illustrated by considering themanagement, outsourcing, offshoring, combined processing team. lifecycle of a typical Asset Servicing event,near shoring, what’s next on the which is as follows:horizon? Utilities in other industries have been around for a number of years. The key 1. Announcement Capture – Creating a Golden Event38 TCS BaNCS Research Journal

The key to their 7. Accounting/Transaction Postings – • There would be no need to managesuccess was to offer Booking the economic results to the Change Programs, as the Utility woulda standard service host record-keeping/position systems do this for all clientspackage from where aclient can buy as much 8. Claims Management – Identification • The retirement/de-commissioning ofof the services offered of, claiming of and payment of, current software and systemsand as they needed, economic results that are not receivedgiving them the directly • A reduction in maintenance and otherfreedom to pick and supplier costschoose and decide 9. Payments – The distribution of results/how best to interface benefits to final beneficiaries clients The key to the Utility is a Standard Servicewith their existing where the client simply chooses whatoperations and 10. Tax – Identification, calculation, from the service they wish to utilizesystems architecture. recording, claiming, payments versus what parts of the service they which to retain. The decision is based on: Let’s focus on step 1 here to illustrate the Utility Service. It’s common market data • Existing processes, including current as provided by an exchange, a market automation (cost and sophistication) data vendor or a custodian, and can be processed by the Utility as a shared • Current headcount footprint service and offered to multiple clients. It’s possible that one client may have a • Prevailing systems and the ease preference or priority for one vendor/data of uncoupling the architectural source over another, but the data is still components and de-commissioning the same. • Level of control retained and preferred Therefore, looking at the Announcement Capture process alone, by operating • Processes, which are deemed within a Utility Service, clients will benefit customer sensitive by:2. Event Enhancement – Adding extra • Not having to operate their own The key to the Utility and additional details that are rule/ internal Announcement Capture is a Standard Service offset driven, but not contained within process where the client the announcement details simply chooses what • Not having to employ staff who check from the service they3. Position Eligibility – Identifying the incoming announcements wish to utilize versus positions allowed to participate in the what parts of the event • Not having to manage a comparison service they which to and scrubbing process retain.4. Entitlements – Calculating the In addition to this, from a technology economic results of the event perspective, the benefits are:5. Notifications – Keeping impacted • There would be no need to manage parties informed, throughout the changes made by individual vendors event, of status and actions • Changes to their proprietary feeds or6. Election/Instruction – For an elective to an ISO standard interface, would be event managed by the Utility TCS BaNCS Research Journal 39

• Processes deemed to be of too high a What has been shown so far is that the changes in the law and regulations to risk end-to-end process for Asset Servicing adhere to, the client will still need a can be processed within the Utility. The percentage of the retained organizationIn addition to Announcement Capture, question arises about whether there are to complete, control or undertake certaincan the other steps mentioned be any functions or tasks that would not processes.undertaken within the Utility? Yes be part of the Utility. Or for that matter, what kind of processes would the client Further, the issue of customer sensitivityThe appetite for what is undertaken and retain? is a key factor for consideration, wherethe preferences of one over another the client would not want their detailswill be determined by the clients’ view; This will depend on the clients’ view of shared with the Utility. One optionalthough, besides certain specific retained risk and control, and to some degree, therefore would be to mask the specificfunctions processes, there are no other their current and past experiences. But it account details from the Utility, andreasons why other steps outlined cannot must be remembered that the more you this would apply to any static data,be undertaken within the Utility. After offer the Utility, the greater the benefits address and communication information.all, they are common actions and can for the client. Alternatively, the client may wish tobe performed in a standard way. A few retain some of the client services/facingexamples of some of the further actions Though, due to increased levels of activities.under a Utility are listed below. controls by regulators and increasedArea Task/Function/ProcessEvent EnhancementCalculating Entitlements Identify and apply event and option restrictions based on positions.Election/Instruction Creation of common actions and dates not advised within the announcement.Claims/Payments Using event rate and tax, as common for all clients. Using entity/position tax rates.Tax Using traded tax rates. View by Firm/Customer V Street/Market. Capture of common market/custodian deadlines. Capture of counter party deadlines. Allocation of deadlines to Long positions. Receipt of elections. Allocation of elections received to Short positions. Arbitrage decisions. Instruction Acknowledgment - AXK/NACK Identification and creation of payable and receivable claims. Identification of auto-settlement. Identification of third-party claims vendor settlement. Identification of direct settlement. Common management and reporting of claims. Tax reclamation. Tax reporting. Communication with local and foreign regulators.40 TCS BaNCS Research Journal

One option therefore control could further assist with the Risks and concerns around a utility are: would be to mask internal process of cash management/ the specific account funding. • Shared client data details from the Utility, and this The process of election and instruction • Customer confidentiality would apply to any management has traditionally been static data, address sensitive, especially with the setting of • Incorrect Non-processing of an event and communication deadlines. However the Utility would or a task within an event information. perform all the tasks and functions until a Alternatively, the set time before a deadline at which point • Preference over one client to another client may wish to the process of late election management, retain some of the allocation, arbitrage and instruction • Sharing of sensitive data client services/facing would be managed by the clients, as a activities. retained service. • Using another client’s security positionsCommunication (or escalation) with a In the case of a single client utility, andthird-party: The client may wish to retain where a client has multiple business • Accidental misuse of client data/and control any custodian or vendor units and divisions, how would this informationrelationship though, as most queries are work?event information related, there may • Missed/incorrect instructiononly be the need for the client to have The Utility would work equally wellthe ability to escalate in order to resolve across multiple clients as well as with one The above risks are well known withindisputes. For positional differences client with multiple business units (such the current processing landscape and asqueries, there could be sensitivity issues as Retail and Institutional Investment, such the utility would take measures asaround the account positions, activity Asset Management, Custody, Investment the client would do today to prevent theirand movements, and so, again, a client Banking). As with the multiple clientservices team may be retained. model, the details from the event are The utility across an common, with position extracts from entire organizationInternal compliance may dictate that the multiple systems, with eligibility and will drastically improvepayment process and client host system entitlement roles being common. the intra-company/updates may require a final release inter-entity processingby the client. This will also allow for The issues around client confidentiality relationship andcustomer and counterparty settlement and data masking would still remain but would further removeand payment instructions to remain the Utility would still offer one operational or reduce duplicatedmasked or with the client. This retained team with one common processing tasks and functions, system. Exceptions, authorizations and ensuring that escalations could be routed to existing organizations worked client services teams as retained within towards an ethos of the existing structure. processing only once. The Utility across an entire organization will drastically improve the intra- company/inter-entity processing relationship and would further remove or reduce duplicated tasks and functions ensuring that organizations worked towards an ethos of processing only once. TCS BaNCS Research Journal 41

By using strict What about certain event types being • Transactions Fees: A variable fee based management control considered with the Utility rather than on transaction volumes and exception as a package of processes within the processing, the utility offered service? This would be considered • Processing Fees: A variable fee would aim to ensure more within the migration strategy to the calculated on the number of that exceptions, issues Utility and the approach could be further exceptions having to be processed, and authorization used by the Utility and the client to gain which will be used to encourage requests are made confidence and trust within the overall higher STP rates to the correct parties offering. and with the correct • Maintenance Fees: Applied to cover timing, by using an Though the view would be for the Utility change and update programs, such interactive client user to offer the service package as it is, it as implementing the annual Swift Interface. could be restricted to only cover certain changes groups of event types, such as Income,occurrence. By using strict management mandatory or voluntary. In summary, the advantages to a clientcontrol and exception processing, for subscribing to a Utility Service are:the utility would aim to ensure thatexceptions, issues and authorization However, to benefit fully from the de- • A fixed/known cost for Asset Servicingrequests are made to the correct parties commissioning of savings and to maximize Operationsand with the correct timing, by using an operational efficiency, the event groupinteractive client user Interface. split would not be ideal, unless the • A reduction in operations costs processes are undertaken by separate processing systems. • A contractual standard service supplied by a vendor to multiple How would such an offering be priced? clients There would be a combination of • A standard service, which is flexible for components used to calculate the service clients to choose what elements of the price made up of: service are taken over • Subscription Fees: A fixed fee based on • Maximizing efficiencies by using event volumes common technology that will be maintained and serviced to meet market and regulatory changes • Reduction of cost and effort in change programs, covering market, regulatory, interface changes • An increase in de-commissioning of old expensive systems Alan Lawman • A rationalization and simplification of existing technology architecture Consultant TCS Financial Solutions • A reduction in maintenance, license and other supplier costs42 TCS BaNCS Research Journal



Shortening the Securities andCash Settlement Cycle from T+3to T+2Bringing efficiency to the entire trade increase in settlement failure. Many for securities to not later than T+2 and tolifecycle is the key to decreasing risk. With firms cite inaccurate settlement and be implemented by 2015. This mandateincreased cross border trade activities, account instruction (SI) data as the most by the EC is not only focused at drivingthe post trade process continues to be significant reason for failure, followed market efficiency but also promisescomplex and challenging for investment by the deliberate failure to settle by to act as an important enabler for thefirms due to lack of harmonization in counterparties and mismatches between Target2Securities (T2S) implementationmarket practices. Despite technology cash and securities cycles. Both buy side program. Countries such as India, Hongadvances and business process and sell side firms are looking to mitigate Kong, Taiwan and Germany that haveimprovements, there are inefficiencies in counterparty and operational risks as well transitioned to the T+2 settlement cyclethe settlement process leading to trade as to reduce costs. have shown improvement in marketand settlement failure. The cost of stock efficiencies with decline in settlementborrowing to avert the risk of trade failure Recently, the European Commission (EC) failures and the associated risks.has increased because of the exponential mandated reducing the settlement cycle Reducing the settlement cycle from T+344 TCS BaNCS Research Journal

to T+1 poses high risk and challenges improve efficiencies through automation. UK follow T+3 settlement cycles forto market participants due to the lack However, there are concerns that cash and securities. With the adoptionof key enablers, technology limitations reducing the settlement cycle will increase of Target2Securities (T2S) in progress,and increased investments required for the risk of settlement failure particularly there is a need for harmonizing theimplementation. On the other hand, in the absence of a trade matching or settlement cycle across asset classes andtransitioning to T+2 requires lesser confirmation process. This paper analyzes establishing a uniform practice acrossinvestment with fewer changes to the the potential impact of shortening the countries to enable smooth cross borderbusiness processes by each participant. equities settlement cycle from T+3 to T+2. transactions. A recent study by OmgeoThe most important change required indicates that there is a direct correlationfor transition is to mandate market 2. Shortening the Settlement Cycle between high Same Day Affirmation(SDA)participants to affirm trades on the day rates and high settlement rates. Forthe trade is executed, enabling timely and 2.1. Current Scenario instance, countries with short settlementaccurate settlement. cycles such as India, Hong Kong and Today, most of the market participants Taiwan which adopted T+2 early haveFirms must look beyond short-term goals cite inaccurate settlement and account better settlement efficiency thanand evaluate options to re-engineer instruction (SI) data between buy side countries like the USA, UK and otherbusiness processes and enhance IT and custodians, the deliberate failure to European countries. Today, a majorityinfrastructure of the impacted business settle by counterparties, and mismatches of the Central Securities Depositoriesareas before transitioning to a reduced between cash and securities cycles as (CSD) have a penalty scheme in placesettlement cycle. They must view this the reasons for settlement failure. There for late settlement, although the typeas an opportunity to invest in their are different settlement cycles across of fee levied varies across marketstechnology infrastructure, to achieve the different asset classes ranging from T+0 to (recycling fee vs. penalty fee, with someend objective of decreasing risk while T+3 which limits the participants’ ability CSDs charging both). These penalty feesenhancing business efficiency. to hedge complex products efficiently. form a part of CSD revenue and apply Table 1 shows a snapshot of the present to a broad set of transfer instructions,1. Introduction length of the settlement cycle for various both for settlement failures due to lack securities in the USA. of securities or lack of cash. In order toOver the years, the financial services support settlement efficiency and reduceindustry has spent a substantial amount In Europe, except Germany and the incidence of settlement failure,of money speeding up the trading Slovenia, other countries including the CSDs are offering securities lendingprocess, but not a lot on the middle andback office for post-trade process. With Table 1: Settlement Cycles in USA across Asset Classesrecent changes to market structures,regulators have initiated important steps Settlement Cycle Task/Function/Processtoward improving operational efficiencies Tand reducing risks (credit and liquidity) T+1 • Bank certificates of deposit (CDs)by shortening the equity trade settlement • Commercial papercycle. This initiative from the European T+2Commission has spurred the United States T+3 • Futuresand other Asian countries (except India, • OptionsSouth Korea, Hong Kong and Taiwan) • U.S. Treasury securitieswith divergent cycles to reconsider theadoption of T+2 as the standard equity • Currency or foreign exchangesettlement cycle. This initiative providesan opportunity to market participants • Corporate and municipal bondsto streamline processes in the middle- • Equitiesoffice to reduce operational risks and TCS BaNCS Research Journal 45

and borrowing services ranging from 2.2. Challenges with the current trades. This requires parallelproviding technical facilities to enable settlement cycle processing which involves significantmatching of lenders and borrowers to investments in hardware andacting as principals in a securities lending Table 2 elaborates the challenges faced by middleware.and borrowing transaction. In the current the existing settlement cycle that need toscenario, a few of the major European be addressed to transition to a reduced • The order-management or portfolio-CSDs report that nearly 20 to 50% of settlement cycle: accounting systems have to be re-the transactions are settled in less than designed to rule based processing/T+3 and, 45% to 65% in T+3 while a • The back-office system should be complex event processing (CEP)very small proportion have a longer capable of real-time, concurrent platforms similar to FX platforms. Buysettlement period. multi-stage trade-data enrichment side firms will struggle to support for executing, allocating and settlingTable 2:Flow Activities Current Settlement Reduced Settlement Cycle T+2 Reduced Settlement cycle T+3/T+5 CycleT+1Trade • Trade order High frequency and No change No change • Trade execution algorithmic tradingVerification • Confirmation Most trade transactions • Mandate order matching for all SDA and matching to be • Affirmation (institutional) confirmed trade transactions to centrally performed in real time • Order matching and centrally matched match to settle beyond T+1 day • Achieve same-day affirmation (SDA) before T+1 morningClearing • Trade clearance • Longer time Need to tune the clearing process Perform near real time • Trade netting required for clearing batch cycles to accommodate the margining and netting • Settlement physical certificates/ volumes on or before T+1 process on per trade prospectus basis Instruction requirements • Counterparty risk • Clearing • Increase in clearing fund requirementsSettlement • Transfer of securities • Inefficiencies • Improve communication and • Need to build • Transfer of money in settlement adopt messaging standards interbank bulk • Confirmation of instructions for STP(Straight-Through- payment facility generation and Processing) solution between settlement maintenance buy side and custodians • Broker and client to offer pre-payment • Cheque clearing and • Automate the payment facility FX settlement follow process between brokerage T+2 cycle firms, Central Counterparty Clearing Houses (CCP)s/CSDs and the client side • Enable reduced cheque clearing time through digitization • Mandate the payout of funds and securities by broker to the client on T+246 TCS BaNCS Research Journal

the changes due to the presence of • Firms will need to implement high- management system for continuous multiple platforms. availability systems such as real-time monitoring of operations, processes data and application backup and have and infrastructure systems.• Firms will need to improve their disaster recovery mechanisms in place data infrastructure due to reduced to switch to a standby system without 2.4. Changes required for a transition time available for reconciliation losing any transactions. from T+3 toT+2 settlement cycle and correction of data. Adopting an appropriate data infrastructure to • Buy side firms will need to enable Table 3 details the day-wise process manage and process data to cater real-time monitoring of trade status related changes required to transition to to these changes and demands will and implement an operational risk T+2 settlement cycle. require significant investments.Table 3: Action to be performed by key participantsParticipants T+0 T+1 T+2CCPs • Ensure all trade confirmations are • Ensure that the final transfersBrokerage received by morning of funds and securities occursCustodians simultaneously at the end ofCSDs • Ensure availability of exception afternoon window with additional chargesPayment for late confirmation • Set up mechanism for handlingBanks shortages of funds and securities • Perform multilateral netting and novation • Perform corporate actions event processing • Compute variation in margin • Generate and transfer settlement instructions • Perform centralized matching for • Submit settlement instructions • Receive transfer message all institutional trades files and payment instructions files confirmations for funds and to the depository and the clearing securities from clearing banks and • Perform same day affirmation bank depositories • Transfer funds and securities from clients’ accounts to brokers’ accounts • Ensure electronic confirmation of trades by institutional players to custodians • Mandate entry of unique identifier code (client code) assigned to the sub-account/scheme at the time of order entry • Perform settlement instruction • Receive confirmation of cash validation, enrichment, processing settlement from the payment bank and matching of trades • Perform Security Lending • Generate receipt of settlement Borrowing (SLB) action in case of confirmation shortage of securities • Ensure soft lock of securities in the • Execute simultaneous position and DP account balance adjustments on successful confirmation of fund transfer • Generate settlement notifications • Validate and process cash • Conduct special clearing session settlement instruction to facilitate quick and efficient movement of funds TCS BaNCS Research Journal 47

2.5. Benefits and costs associated with reduced settlement periodsTable 4 compares and contrasts the key benefits and costs of the proposed reduced settlement cycle with the existing settlement cycleTable 4: Cost and benefit of reducing settlement cycle T+2 T+3Benefits • Reduced counterparty risk (and associated • Low operational risks since fewer markets wouldCost market and liquidity risks) by one day for T+3 require the settlement period to be extended markets for cross border trades. • Increased automation of back-office processes and operations of market participants • Reduced annual collateral requirements help in improving the liquidity risks and thereby improve capital utilization by market participants • Investment (one-off) costs for more market • Increased counterparty risk (and associated participants than in the T+3 option, mostly for market and liquidity risks) by one day for T+2 the smaller players markets • Possible rise in settlement failures in the short • Increase collateral requirement thereby putting term as back offices need to adapt to the pressure on additional capital required by the change market participants • No major regulatory costs, as in most countries, a transition to a reduced settlement cycle would not require changes2.6. Measures to be followed to move to confirmation of institutional trades by Case 3 - Hong Kong has recently movedthe T+2 settlement cycle custodians latest by 1.00 a.m. on T+1. to the T+2 settlement cycle with a pre- payment option on exchange tradesTable 5 lists the key measures required for Case 2 -Taiwan moved to the T+2 settled in the Central Clearing anda smooth transition to the T+2 settlement settlement cycle and made changes to Settlement System (CCASS), operatedcycle. the implementation process, similar to by HKEx’s wholly-owned subsidiary, India. The changes included introducing Hong Kong Securities Clearing Company3. Experience across different a pre-settlement mechanism, in which (HKSCC). However, for the non-pre-geographies custodian banks need to confirm pre- payment option, the settlement settlement for the executed DVP trades mechanism follows the T+3 cycle forCase 1 - India moved to the T+2 by T+1 afternoon, and trade affirmation securities and money settlement. Forsettlement cycle in 2003 though the between investors and brokers on the T+2 settlement cycle, the paymentonline fund settlement system was at a T+1. Further, local sub-custodians are obligation is fulfilled using overnightnascent stage. Despite the movement required to send trade affirmation to the interbank bulk settlement processesof funds under the Real-Time Gross execution brokers on T+1 to facilitate by the Hong Kong Interbank ClearingSettlement (RTGS) system not being trade settlement on T+2. Limited (HKICL). With this settlementsmooth, the regulator mandated arrangement, Hong Kong has bridged48 TCS BaNCS Research Journal

Table 5: Measures of market discipline for T+2 settlement transitionAreas Measure BenchmarkEarly matching of • Efficient trade confirmation processes • Confirm on T+0 date and performing centralizedinstructions • Efficient matching processes matching by T+1Early settlement on • Continuous settlement throughout the day • Settlement run every hourintended settlement • Promotion of early settlement throughdate appropriate measuresPrevention of failed • Monitor failures, admonitions, securities lending • Regular publication of failed settlements datasettlements • Buy-in at the end of the settlement date with the respective ISIN (/CUSIP numbers • Hold-release mechanisms to induce early matching and allow matching to be separated from the availability of cash or securitiesSettlement of failed • Penalties for late settlement • Ensure guarantees are in place and in maintaining over-collateralized positionstransactions • Suspension from market activitiesPhysical securities • Design an alternative clearing and settlementclearing process system for paper traded shares in line with T+2 settlement cycleBack office • Build STP process for automatic downloading ofautomation of instruction files for securities and fundsbroker dealerCross industry • Adopt low cost, accepted standards and • Adopt the ISO 20022 standard – a stepsettlement common mode of communication between buy towards unification of standards for post tradeinstruction solution side, sell side and custodians settlementthe gaps and adopted international institutional investors) is required, it noon one day after the trade is executedbest practices by finalizing securities should occur as soon as possible after through a regulatory rule NI 24-101 intransactions including money settlement trade execution, preferably on T+0, 2007. Due to this regulation, many ofon the same day. but no later than T+1. the Canadian investment management firms focused on improving the process• From the above cases, it is clear that • Pre-payment options can be efficiency of post-trade operations. one of the critical success factors for leveraged to eliminate funding shortening the settlement cycle is bottlenecks and act as an enabler • Three years after enforcing the the confirmation of trades between for market participants to adopt regulation, the domestic Canadian direct market participants as soon as the change faster. Mandating same market is increasingly automated. possible after trade execution, but no day affirmation helps in improving While 93% of investment managers later than the trade date (T+0). settlement efficiencies. use electronic trade matching solutions for equity trades, 80% use• Where confirmation of trades by Case - Canada mandated that 90% of it for fixed income trades. For cross- indirect market participants (such as the institutional trades be matched by TCS BaNCS Research Journal 49

Firms will need to cycle, the European commission can • Pre-payment options eliminating the implement high- aim for smoother adoption of its funding bottlenecks and also acting as availability systems Target2Securities program and then look an enabler for market participants to such as real-time at opportunities to harmonize corporation adopt the change faster data and application actions cycles. backups and have • Early matching of instructions and disaster recovery Smooth implementation by market promotion of early settlement by CSDs mechanisms in place participants, however, requires adopting to switch to a standby a methodological approach. Transitioning • Prevention of failed settlements system without losing directly to a T+1 settlement cycle is through continuous monitoring and any transactions. challenged by technology limitations and measures for improving settlement key business risks impacting the overall efficiencies border transactions, 80% are using implementation. Hence moving to T+2 trade matching for equities and 74% can be the first step with key enablers • Promoting regulations in bringing use it for fixed income. such as building stronger payment and efficiency in post trade operations. foreign exchange infrastructure. With this• As a result of this regulation and in place, adoption of T+1 adoption can be Investment management firms, asset investment in back office systems, re-evaluated and subsequently executed. management firms and custodians should Canadian investment firms and not consider shortening settlement cycles custodians are confident of adapting Moving from the existing T+3 to T+2 a regulatory burden. They should look to changes in trade settlement cycles settlement cycle is considered less risky at it as an opportunity to improve their in North America and Europe. given the current scenario. However, systems and processes thereby reducing it will require some business process trade lifecycle risks.4. Conclusion re-engineering efforts in pre-settlement activities by the buy side, custodians Hence moving to T+2Over the years, significant developments and sell side. Market infrastructure firms can be the first stepin front office systems and low latency will have to fine tune their clearing and with key enablerstrading capabilities, which threaten the settlement functions and align with such as buildingstability and integrity of the markets, have changes to the business process. stronger paymentbeen a cause of concern for regulatory and foreign exchangeand other salutatory bodies. Reducing the settlement cycle to T+2 will infrastructure. With bring benefits in the form of reduced this in place, adoptionAt present, the European Commission capital requirement through reduction of of T+1 adoptionis undertaking several initiatives to counterparty and liquidity risk, reduced can be re-evaluatedrationalize the settlement process. collateral requirements for settlements and, subsequently,By standardizing the settlement and improved market efficiency through executed. STP, achieved by enhancing the efficiency of middle and back office processes through automation. For the successful adoption of T+2 settlements, the following need to be in place: • Mandating market participants to affirm trades on the day the trade is executed, enabling both timely and accurate settlement50 TCS BaNCS Research Journal